Over the past two years, homeowners have had to deal with falling prices, a glut of inventory on the market, and tightening credit standards. This week, though, another threat to home prices has come into view, and it could spell disaster for a housing market struggling to find bottom.

This week, interest rates on mortgages rose toward the highest levels in six years. According to Freddie Mac (NYSE:FRE), the average rate on a 30-year mortgage rose to 6.63%, up sharply from just 6.26% the week before. Similarly, rates on adjustable-rate mortgages (ARMs) rose from 5.10% to 5.49% -- all in just one week.

Tough times, steep moves
Of course, this wasn't just any ordinary week for the home-loan industry. Mortgage market-makers Fannie Mae (NYSE:FNM) and Freddie Mac went to the brink of oblivion and back again, as fears of insolvency were at least temporarily squelched by promises of liquidity from the Federal Reserve and further relief from the federal government.

Financial stocks initially rallied on that news. Banks such as Wells Fargo (NYSE:WFC) and Washington Mutual (NYSE:WM), which both have an extensive presence in the hot housing areas of California and the Southwest, saw their shares recover strongly from recent losses, in hopes that investors could put the worst of the housing crisis behind them.

But the mortgage market reacted to the news with much less enthusiasm. For the most part, the bond markets have been relatively stable since last Thursday, with the 30-year Treasury yield staying in a fairly tight range. Surprisingly, despite the proposed government bailout of Fannie and Freddie, spreads for mortgage-backed securities rose to their highest level since the Bear Stearns crisis in March -- leading to the sharp jump in mortgage rates.

Doubts for the future
Asked to explain the higher rates, Freddie Mac's chief economist argued that fears of inflation, continued housing weakness, and the possibility of a rate increase by the Federal Reserve all helped contribute to the spike. Yet there are a number of reasons that those explanations don't seem to hold water:

  • If inflation were a concern, you'd expect to see bond rates in general -- and rates on inflation-protected bonds in particular -- spike just as much as mortgage rates. But they didn't.
  • In a weak housing market, you'd think that reduced demand for mortgage loans should encourage lenders to lower rates to entice reluctant buyers to borrow.
  • Although a Fed rate increase might cause short-term rates to rise, long-term interest rates sometimes fall in response to a rate boost, especially if the bond market perceives that the Fed is finally ready to fight inflation with tighter monetary policy.

What seems the more likely cause is much simpler: Investors are losing confidence in the mortgage-backed-securities market and are demanding a higher reward for their higher perceived risk. And unfortunately, it's everyday average homeowners, along with prospective home buyers, who'll pay the price.

Less buying power, lower prices
High mortgage rates have a number of bad effects on housing. They make it more difficult for existing homeowners to refinance their mortgages, and it could especially hurt those with ARMs set to have their rates adjust upward in the near future. More homeowners could be forced into foreclosure, which could further exacerbate price declines.

For prospective home buyers, high rates on mortgages mean buyers can't afford to pay as much for a home. For instance, buyers who could afford to spend $1,500 per month on a 30-year mortgage could borrow as much as $243,000 with rates at last week's figure of 6.26%. But with rates rising to 6.63%, the same buyers could only afford to borrow about $234,000.

That $9,000 difference isn't huge, but a loss of almost 4% in buying power is significant, especially in higher-priced markets. Moreover, those who stretch their budgets to buy will have less money to spend on related items such as home improvements and furniture, a situation that will further pressure companies such as Home Depot (NYSE:HD), Lowe's (NYSE:LOW), and Ethan Allen (NYSE:ETH).

Watch those rates
The housing market hasn't exactly held up well, even with mortgage rates at reasonably low levels. If recent rises don't reverse themselves quickly, homeowners could easily see a new wave of downward pressure on home prices -- at a time when they can least afford it.

For more on the housing crisis, read about:

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Fool contributor Dan Caplinger probably bought his house at exactly the worst time, but at least he has a fixed-rate mortgage. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy gives you shelter.